Virtus Investment Partners Inc (VRTS) 2017 Q2 法說會逐字稿

Good morning. My name is Kailey, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website at www.virtus.com. This call is also being recorded and will be available for replay on the Virtus website. (Operator Instructions).

I will now turn the conference to your host, Jeanne Hess.

Thank you, and good morning, everyone. On behalf of Virtus Investment Partners, I would like to welcome you to the discussion of our operating and financial results for the second quarter of 2017.

Before we begin, I direct your attention to the important disclosures on Page 2 of the slide presentation that accompanies this webcast. Certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and as such are subject to known and unknown risks and uncertainties, including but not limited to those factors set forth in today's earnings release and discussed in our Annual Report on Form 10-K and quarterly report on Form 10-Q and other SEC filings.

These risks and uncertainties may cause actual results to differ materially from those discussed in the statements. In addition to results presented on a GAAP basis, Virtus uses certain non-GAAP measures to evaluate its financial results. Our non-GAAP financial measures are not substitutes for GAAP financial results and should be read in conjunction with GAAP results.

Reconciliations of these non-GAAP financial measures to the applicable GAAP measures are included in our earnings press release, which is available on our website.

Now I would like to turn the call over to our President and CEO, George Aylward. George?

Thank you, Jeanne. Good morning, everyone. I'll start this morning by discussing the completion of the RidgeWorth acquisition, which marked an important milestone for the company. I will then provide an overview of the results before turning it over to Mike for a more detailed discussion.

On June 1, we closed the acquisition, which added $35.7 billion of long-term assets under management. Total consideration for the acquisition, excluding working capital adjustments, was $533.9 million, representing a purchase price for the business of $472 million and $61.9 million for balance sheet investments.

We funded the consideration due at closing with $457.9 million of cash, which included $260 million of proceeds from a 7-year term loan and $24.3 million of common equity and deferred cash.

Integration activities began shortly after we announced the transaction, and we have made significant progress in all functional areas. On July 14, we completed the fund reorganization, which formally combined the funds managed by our new affiliates into the Virtus mutual funds. During the quarter, we will be executing on the consolidation of fund service providers.

In terms of our expected synergies of $25 million, in the quarter, we executed on $16 million or nearly 2/3 of the total, primarily from employment-related savings of $14 million to the elimination of duplicative positions. We expect the remaining synergies to be substantially realized by the end of the year with the full $25 million expected to be reflected by the first quarter of 2018.

The distribution teams have completed comprehensive product training on the new managers and strategies and are prepared to offer the additional investment solutions to clients in both the retail and institutional channels.

Our national accounts and wholesaling teams have been working with the distribution partners to introduce the additional offerings from Ceredex, Seix and Silvant to home offices and financial advisers. Our new institutional resources, including the international team, have been educated on the strategies from Duff & Phelps, Kayne Anderson Rudnick, Newfleet and Rampart and are focused on identifying opportunities in that channel.

The RidgeWorth acquisition illustrates the benefit of our multi-boutique model, which enables us to diversify and expand our offerings of differentiated strategies by adding new affiliates. We believe our model is attractive to potential affiliates given the alignment of interests, distribution strength and access to capital for investments and growth that we provide. In addition, our shared services allow investment professionals to focus on managing client assets and not be distracted with other activities.

By having a diverse line of differentiated active managers, we were able to offer their distinctive capabilities in multiple markets, channels and product forms while maximizing the leveragability of the business. With $85 billion of long-term assets under management that are diversified by product category, asset class, distribution channel, we believe the combined company is well positioned for long-term success. We have the scale, strength and resources necessary to compete in today's environment, and our model provides additional opportunities for future growth.

So now let me review the results. I will start by noting that, given the timing of the close on June 1 and the resulting partial quarter impact, we recognize that comparability of results will be impacted. So Mike and I will isolate the June results or the contributions in the quarter where appropriate. Now that the businesses have been combined, we do not expect to provide this information in future periods.

Long-term assets under management increased 77% sequentially and 88% from the prior year to $85 billion, primarily reflecting the addition of assets from the acquisition. Flows for the quarter include those generated by our new affiliates for the month of June.

Total sales were $3.5 billion, an increase of 6% on a sequential quarter basis and 44% from the prior-year quarter. The second quarter included $0.5 billion of sales in products managed by our new affiliates.

Total net flows were modestly negative at $0.2 billion in the quarter compared with net inflows of $0.5 billion sequentially. Positive flows in retail separate accounts and ETFs were more than offset by net outflows in structured products and institutional. Net outflows of $0.7 billion in the month of June were attributable to the acquired business and primarily reflect principal pay-downs on a CLO and the impact of institutional clients rebalancing between asset classes. Our relative investment performance continues to be very strong with 83% of our rated fund AUMs having 4 and 5 stars as of June 30.

In terms of what we're seeing in July for flows, mutual fund flows are [flat]. As for the other product categories, the only thing of note is that Seix priced a $500 million CLO that is expected to close in the third quarter.

Moving to the financial results. Operating income, as adjusted, increased 68% from the prior quarter, which included $4.9 million of specific employment expenses. Second quarter operating income included approximately $5.1 million contributed by the acquired business. In the month of June, the combined company generated an operating margin, as adjusted, of approximately 32%. Second quarter earnings per share, as adjusted, increased 39% to $1.61 from $1.16 in the prior quarter, which included $0.41 per share for the specific employment expenses.

Now I'll turn it over to Mike to provide a more detailed view of the financial results and the balance sheet. Mike?

Thank you, George. Good morning, everyone. Starting on Slide 7, assets under management.

Before reviewing the results, I wanted to highlight the changes we made to the AUM disclosures in our earnings release tables. We have added 2 product categories: structured products and liquidity. Historically, we presented structured products as a component of institutional, but in the past year, a CLO was issued by Newfleet and Seix as a seasoned CLO issuer. Given that we expect to remain active in this product category, we have separated it into its own category and reclassified prior periods to conform to the new presentation.

The liquidity category reflects strategies that can have short holding periods and significant volatility inflows. Similar to how we treated cash management products, these assets are excluded from long-term AUM and net flows. These low-fee fixed income strategies are available in mutual funds and institutional accounts.

We ended the quarter with long-term assets of $85 billion, which represent increases of 77% and 88% from the prior quarter and the prior year quarter, respectively. The sequential change reflects that $35.7 billion of assets from the acquisition and market appreciation of $1.7 billion, partially offset by net dividend distributions and modest net outflows of $0.2 billion. The change from the prior year reflects the assets from the acquisition, market appreciation of $4.4 billion and positive net flows.

With the additional assets from our new affiliates, our long-term AUM is well diversified by product type with $41.5 billion in open-end funds, $20.6 billion in institutional, $12.4 billion of retail separate accounts and $2.9 billion of structured products. The acquisition further diversified our long-term AUM by asset class and investment style with 37% in domestic equity with approximately 17% of that in small cap, 15% in large cap and 5% in mid-cap. Non-U. S. equity was 12% with 9% in emerging markets and 3% in developed.

Fixed income was 46% with approximately 20% in leveraged finance, 16% in investment grade, 10% in multi-sector, and alternatives were 5%.

Turning to Slide 8, asset flows. Total sales were $3.5 billion, an increase of $0.2 billion or 6% sequentially. Total sales increased from the prior-year quarter by 44% or $1.1 billion on higher sales in all product categories. Total redemptions were $3.7 billion, which included $1.1 billion of redemptions in June from the acquired business as a result of CLO principal pay-downs and institutional client rebalances. Redemptions declined from $4.6 billion in the prior-year quarter on meaningfully lower mutual fund redemptions.

Net outflows were $0.2 billion in the quarter. Excluding $0.7 billion of net outflows from the acquired business, net flows were positive $0.5 billion in the quarter and positive $1 billion on a year-to-date basis. Net flows in other product categories included $0.2 billion in retail separate accounts and $0.1 billion in ETFs. With respect to mutual funds, we were net flow neutral in the quarter. That included positive contributions from small-cap equity, emerging markets and floating-rate products.

Turning to Slide 9. Investment managed

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as adjusted were $74.3 million and included $11.5 million earned by our new affiliates. I would note that there were no performance fees earned on structured products in June. Excluding the assets from the acquisition, average assets increased 5% in the quarter due to positive net flows and market appreciation.

The acquisition impacted the fee rates for certain products, including institutional and retail separate accounts. We have provided the June fee rates for those categories, which were 30 and 47 basis points, respectively. While annualizing one month of activity has inherent limitations, we believe it may be useful in estimating third quarter investment management fees.

With respect to open-end fund fee rates going forward, we estimate that after giving effect to the fund reorganization that we completed in July, the open-end fund fee rate for the third quarter will be approximately 47 to 49 basis points, all else being equal.

The decline in the rate compared to the second quarter is a result of all the new Virtus funds from the acquisition having expense caps in place that will absorb and offset any new ancillary revenue streams, such as admin and TA fees. As we complete the consolidation of service providers, the overall expense profile of our funds will change, which will impact our net fee rate, and we will update you as appropriate.

Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses, as adjusted, of $40.9 million, included $4.2 million of additional expenses related to the new employees that joined the company at the time of the close. Excluding those costs, expenses decreased $2.9 million or 7% on a sequential quarter basis.

The decline from the first quarter reflected specific items of $4.9 million, primarily seasonal costs that did not recur, partially offset by increased variable profit and sales-based incentive compensation. As a percentage of revenues, as adjusted, employment expenses were 52% for the quarter. For the month of June, the employment ratio was 50%.

The trend in other operating expenses, as adjusted, reflects the timing of product distribution and operational activities. Other operating expenses, as adjusted, were $14.2 million, which included the additional $1.5 million of expenses for one month of the quarter following the acquisition. Excluding those costs, other operating expenses were $12.7 million, an increase of $1.8 million or 17% compared to the first quarter. The increase was primarily driven by the annual grant to the Board of Directors that totaled $0.7 million and $0.7 million of higher sales and marketing costs.

Given our expectation of expense levels following the acquisition and the timing of additional synergies by year-end, we believe a range of $15 million to $16 million for other operating expenses as adjusted is reasonable.

Slide 12 illustrates the trend of adjusted results. In the second quarter, operating income, as adjusted, was $22.7 million with a related margin of 29%, an increase from $13.5 million and 21% in the prior quarter and $16.7 million and 27% in the prior-year quarter. The current quarter included approximately $5.1 million from the acquired business. Earnings per share, as adjusted, were $1.61 in the quarter, an increase of $0.45 or 39% sequentially and $0.37 or 30% over the prior year.

Looking at the results for June, the first full month of the combined business, revenues, as adjusted, were $33.4 million and operating income, as adjusted, was $10.9 million. And the adjusted operating margin was 32%.

With respect to GAAP results, we reported a loss per share of $0.34 that included the following items: $0.11 per share of incremental interest expense for one month related to the term loan; $0.14 per share of amortization expense for one month associated with acquisition-related intangible assets; $0.21 per share of discrete tax adjustments; and $1.63 per share of acquisition and integration costs.

In order to provide transparency into the acquisition and integration expenses, we've presented these costs separately in the reconciliation of GAAP to non-GAAP results. The category provides additional detail on 4 line items: Employment, severance, other operating expenses and interest expense.

Specifically, employment expenses of $2.1 million include acquisition-related stock grants and compensation related to employees that have been notified of termination, but are serving in a transition capacity for a specific period of time.

Severance expenses of $8.6 million reflect the costs associated with employees whose positions were eliminated at the time of the transaction. Other operating expenses of $5.6 million include professional fees incurred to complete the acquisition as well as costs related to the mutual fund reorganizations.

Interest expense of $2.3 million includes the writeoff of previously deferred financing costs on our prior credit facility that was terminated in June and delayed draw fees incurred on our new term loan for the period between April 1 and the June 1 closing.

The effective tax rate was approximately 99%. The quarter included discrete tax items of $1.5 million primarily related to the establishment of a valuation allowance on certain state net operating losses. Our effective tax rate for non-GAAP purposes, which excludes discrete items, was 38%.

Slight 13 shows the trend of our capital position and related liquidity metrics. The total consideration for the acquisition was $533.9 million, equal to $472 million plus $61.9 million for certain CLO investments.

At the close, we funded consideration of $482.2 million with $457.9 million of cash, $21.7 million in issued common equity and $2.6 million in deferred cash. The remaining $51.7 million was recorded as a contingent consideration that will be paid in the fourth quarter of 2017.

The cash consideration was funded in part by the issuance of a $260 million term loan. The annualized effective interest rate for June on the outstanding debt was approximately 6.2% and reflects both the stated interest rate of LIBOR plus 375 basis points and deferred financing costs, which are being amortized over the term of the loan.

Under our credit agreement, we have a net debt maintenance covenant of 2.5x net debt to bank EBITDA with scheduled reductions to 1.75x over the next 18 months. Bank EBITDA is defined in the credit agreement as operating income as adjusted, excluding stock-based compensation and including dividend and interest income. We ended the period with $184 million of net debt that resulted in net debt to bank EBITDA ratio of 1.1x as of June 30.

We ended the quarter with $49 million of working capital, which represented 22% of annualized spend as adjusted. We also have $100 million of capacity on our credit facility that was undrawn as of June 30. Our target range for the working capital metric is 50% to 75%, and we will continue to manage our capital structure to ensure adequate financial flexibility. In terms of capital priorities going forward, we believe we are well positioned with adequate levels of capital to invest in growth opportunities, to support our affiliates, pay down debt and return capital to shareholders.

With that, let me turn the call back over to George. George?

Thanks, Mike. So that concludes our prepared remarks. And now we'll take all of your questions. Kailey, can you open up the lines, please?

(Operator Instructions) Our first question comes from the line of Michael Carrier with Bank of America.

First question, you just -- given the combination -- George, I think you mentioned, the distribution teams getting ramped up on the different products. So just wanted to get your perspective on the opportunity that you see with the RidgeWorth products? And then just on the fee rate, given that a lot of the funds have been combined, I just want to make sure like when you look at the industry and the competitive environment, where fees by product looked at not only to combine the products but also just given some of the pricing changes that we're seeing in the industry, was that taken into consideration?

Sure. So I'll start with the first question. So in the terms of the opportunity, I think, as we said from the very beginning when we announced the transaction, we were very excited about the opportunity to offer the capabilities from the affiliates at RidgeWorth. And our folks are retail people, both the internal and external wholesalers, from the very beginning of the announcement, they actually did their own research, and then we did a lot of our own product training, including having our first combined sales meeting in June, where we literally had 100 people in a room being, sharing and learning each other's ideas. So we've been very excited about those opportunities. And their strategies were available at many firms and had some access. But combining the good strategies and the access they have with our resources that will help promote, augment and, hopefully get more attention, we continue to see that as a great opportunity. We have not included, as we've said on previous calls, any revenue or growth estimates in the accretion numbers that we've previously given. We believe there are great opportunities, but we have not included any of that. And then similarly on the institutional side, having some resources, including limited resources outside of the U.S. to be able to at least look for opportunities for our original managers is also something we see great opportunities for. So everyone, I think, is very excited about having the additional capabilities, and working with their clients and prospects to see what we can do with that. In terms of the fee rates, Mike might go into a little more detail, but just generically, the way you look at it is we constantly have to monitor our fee rates to make that they're competitive and that our distribution partners are comfortable with the rates that we're offering. If you go through the last 12 months, you'll see there have been multiple funds where we have either put on additional caps or reduced fees primarily more recently in some of the fixed income stuff. And then as part of the transaction with RidgeWorth, both our fund boards, their fund boards and management are all very sensitive to make sure that the fee caps that are currently in place are reasonable for shareholders. So all that comes in together as we monitor that. Mike, anything...?

Yes, I would just add that we try to provide transparency into the June-only fee rates where there was an impact of there being a larger proportion of fixed income, lower-fee assets in the portfolio. So you saw that in the retail separate accounts to look to the 47 basis points, institutional accounts 30 basis points. And then we gave a range in the third quarter for open-end funds given the reorganization that happened earlier in the third quarter. But importantly, our view is that there's no net impact of some of that reorganization that'll happen on a go-forward basis.

Okay. That's helpful. And then just as a follow-up, Mike, just on the expenses, like the comp ratio and the noncomp -- that guidance is helpful. In terms of the synergies, given that you're -- it seems like you're realizing it may be a little faster than originally expected, just in terms of the overall amount, you're still like the $25 million is what you expect you to achieve, meaning there's nothing in addition, other than obviously the revenue synergy opportunities?

Yes, I think $25 million is still the best assumption to use and, as we indicated, we expect to see that as we move into 2018.

Our next question comes from the line of Andrew Disdier with Sandler O'Neill.

First, just -- so on the asset side, generally, with the deal, do you see some type of flow attrition? And I know you noted the $700 million net out. Given the retail skew may be a bit more insulated from that dynamic, just wondering, could you elaborate more on that $700 million during this -- the integration process? And then, second, do you see anything else coming out in the pipeline?

Well, just a generic comment in terms of the impact of any transaction on clients or on flows, the transaction was announced back in December. And so obviously, all of the clients on both the institutional and retail side have had a very long period of time prior to close to really sort of get -- understand and get comfortable with the transaction. So you really should think about it in terms of this is something that began basically on December 16. As we've indicated throughout the client consent process, we have been very pleased with the client consent process, and we've effectively...

Received 100% client.

We received about 100% client accrual, which we were very pleased with, and that's a great test of it to the incredible folks at Ceredex, Seix and Silvant in terms of working with their clients and making sure that they were comfortable with that. So I would sort of think about that in terms of deal-implicated flows. Just in terms of the month of June -- Mike can gave you some detail, but again, it's one month. There's little things that go on all the time and, Mike, if you just want to go through the...

Yes, and I think we try to provide some transparency in the prepared remarks. But, again, of that $700 million, $200 million or about $225 million was related to principal pay-downs in the CLO portfolio at Seix. So that'll happen from occasion, and we'd expect that with the sizable CLO portfolio that we have, and again, that's one of the reasons we broke that category out separately in the AUM tables to provide that transparency. With respect to the institutional outflows, I think there's specifically 2 client accounts that rebalanced their portfolios from domestic equity exposure to international equity exposure. And as we talked about the performance in domestic strategies remains very strong, and certainly, there are buy ratings at some of the main institutional consultants at the manager. So there's nothing there that we would read into other than the rebalance.

Got it. That helps. And then second on the expense base. I noticed the $16 million of synergies, about $14 million you said were from employment. And so I guess where do you see the future synergies coming from? And then on the backwards-looking event then, what was the timing on that? Was it at beginning of June or kind of towards the end of the month?

Yes, the existing synergies, we sort of gave some insights into the June results, and you can -- you could expect that the entire $16 million has been sort-of taken out of the June results to provide that 32% margin that we identified as the full impact of that $16 million. With respect to the additional $9 million, I think I looked at employment expenses at the ratio. We gave the 50% ratio for June as the best way to think about employment. I wouldn't expect further synergies to come from that line. So I would expect the synergies to come from the other lines, and we do expect to achieve those by the end of the year. So you'll fully see then the results going forward into 2018.

So to add that, I think about the employment-related items, which were, obviously, the most easily identified and executed on, have effectively been completed. So the remaining things are sort of, if you think about it, relate to more of the operational IT and, as we highlighted in our remarks, work that needs to be done related to our fund service providers. So I think Mike gave some clarity a little bit on how to look at the third quarter where there'll still be some of that activity going, on and that will drag then a little bit into the fourth quarter and then our expectation, as you'll see the full impacts of those results effectively starting in 2018. And as Mike said, the employment line is probably not going to further impact. It'll be in other lines.

Our next question comes from the line of Alex Blostein with Goldman Sachs.

Got a couple things here. I guess, so first, maybe we'll touch on just capital and the balance sheet for a second. So, A, can you talk a little bit about what the contingent payment is dependent on? And is there anything that could move it higher or lower as we're thinking about kind of the impact on that towards the end of the year? And I'm assuming it's going to be paid out with cash. And I guess, more importantly, it seems like there's going to be a fairly large gap between your kind of adjusted earnings and cash earnings given the tax yield and kind of the effective tax rate. So can you just kind of help us bridge what that is on a kind of run rate basis. I guess, you could use June as kind of your proxy. And then, ultimately, where does kind of the buyback come in back into the story given that it doesn't sound like you guys need to delever here.

Let me -- I'll quickly do the first and then the last piece and then Mike will deal with the middle one. In terms of the contingent -- the remaining purchase price, the contingent purchase price was recorded as a contingent purchase price at June 30. But there is no longer any contingency. That number is locked. That number will be paid by the end of the year. So there is no variability left in that number. And in terms of the last piece related to return of capital and so how we think about things, I think our view is our fundamental philosophy towards capital really is unchanged. We still want to continue to balance between protecting the business, investing in growth and returning capital, as we'll continue to look at, at any point in time, what is the highest and best use of our capital. I think, as we've shown over the years, there have been periods where significant share repurchases have been clearly what we thought was the best thing for our shareholders. And there's been times where we've had product opportunities where we've invested there. Now that we've closed on the loan and the debt, and I think, Mike gave you some indications in how we're looking at working capital. And to your first point, we still have a contingent payment to pay. All those things need to settle out, but we still have a very strong balance sheet as it relates to our current cash. Then if you take out the contingent purchase price, as well as seed in other investments, but we're going to continue to evaluate at any point in time what's the best thing. So that's -- Mike, I don't know if you want to add to that before you do the middle piece.

Yes, I think the other items that we'll continue to focus on with capital priorities or the comment on preferred dividends, and we have the excess cash flow sweep in the term loan that we've talked about where, at certain leverage levels, we'll earmark to pay down debt. So we certainly believe that the levels we have, we have flexibility to manage that. With respect to the cash earnings, and we referenced the bank EBITDA metric, there are 2 items, I think, to point out, some differences between the net income as adjusted metric that we report and cash flow. We talked about the tax benefit that comes from the transaction at about $10.8 million or so per year at current tax rates. So we've seen and worked with some people who like to take that on a net present value basis and ascribe some value that way. But certainly, we'll have that tax shield, and that'll impact the cash earnings. The other item is there will be interest and dividend income that we have previously backed out of our net income as adjusted, but those balances, including the CLO investments, will be generating significant amounts of contribution interest and dividend income. Those items are included in the definition of our bank EBITDA. So you'll see really 2 items that'll kind of drift between our results and the term loan results that we think are important to understand, and we'll provide some transparency into that going forward.

Got it. That's helpful. Second question, just around expenses, again, kind of appreciate all the near-term guidance and the synergies. As you guys think about just the growth opportunities for you with the combined franchise and we're seeing bulk of the asset managers report earnings already where spending is kind of going up for many of them for a variety of reasons. How are you guys thinking about organic expense growth for the business keeping synergies out of the discussion?

Yes, that's a good question. I think one of the benefits of this transaction, while there were, obviously, a lot of synergies and a lot of areas where there were duplicative activities, I think as we sort of executed on this transaction, we also wanted to make sure that we had the right level of resources to really drive what we see as exciting opportunities for growth. So just even in terms of retail and pulling in [certain] things, we make sure that we had in the new expense profile in terms of resources and cost that which we thought would be necessary to really be competitive in this environment. Because the environment is getting competitive. So I think in doing this transaction, I think we've set ourselves up for making sure that we can maximize those opportunities. But I do agree with you, it is getting -- it gets more difficult, particularly in the retail world, to be competitive and to really have that what you need to really outcompete some of the other competitors. So I think we're in a good place in terms of that. Mike, is there anything else...?

Yes, I would -- just as we think about the incremental margins of the business going forward, certainly, we talked a little bit about June, but -- incremental margins always are impacted by market conditions, impacted by the type of the AUM. That comes in whether it's from external managers or internal managers. But I think, looking at that at the 50% to 55% range that we've historically been in over time is still probably a good way to think about the business.

Got it. And then the 50% to 55%, it's excluding synergies.

That's right.

Okay, great. And then, just sorry, last one, just to clean up here. Thanks for the kind of added disclosure on AUM. Can you help us just map retail SMA, institutional SMA to which kind of managers comprise the bulk of that asset just kind of helping us align the individual managers to the way you guys are disclosing the products now.

Are just trying to -- so if you look at the bucket of assets, like which managers would be the biggest participants, so like for retail separates versus institutional.

Yes, because [aren't going to get it from a] performance perspective and the flows perspective [whether] it will matter.

We typically haven't provided detailed AUM by manager. We like to provide at a very granular level in the appendix, in our earnings supplement. But we'll still consider if there's any additional incremental disclosure that'll be helpful and appreciate that thought.

Yes, I mean, (inaudible) we just point out and say for like retail separate accounts, our larger managers in that space would include Kayne and -- Seix at institutional -- it's going to be -- again, it's going to be Seix and Ceredex. So I don't know if that helps a little bit. But we always give (inaudible) to whether there's additional information we can provide that would be helpful.

Our next question comes from the line of Ari Ghosh with Credit Suisse.

Just going back to the institutional side a bit. Have you been notified of any upcoming redemptions? As we move forward, and if you can provide any color on the institutional pipeline, that would be helpful just because it's getting to be a little more important as we look at the mix of flows and just your expectations for the second half of the year from the institutional business?

Yes, that's -- when we sort of gave like the indication of what we're seeing so far in July, we sort of spoke to the mutual funds effectively being flat. And then really of what we're sort of aware of at this point, the only thing we thought that was of note was the CLO that we spoke about that was priced since you close in the quarter. In terms of anything else that we thought was significant enough, there is nothing that we highlighted. As it relates to going forward in terms of what we'll do in terms of pipeline and expectations, our goal is to provide clarity on what -- that which we think is important. And as we roll through the next quarter, we'll be giving some thoughts to what other information might be helpful. But from what we said so far from what we're fully aware of as of July, the only thing we noted was the CLO.

Got it. And then just real quick on the expense caps. How much of this was driven by conversations that you've been having with your distribution partners versus just an internal review where the fee rates stand. And then I think maybe 9 months ago, only a small portion of total retail AUM, maybe 5% of it, was impacted by maybe the expense caps (inaudible). Can you put that in perspective right now, the magnitude of both the AUMs that were impacted as well as the size of the reduction?

Well, I just want to be clear. The majority of funds have caps. And on our side as well as on the RidgeWorth side, that is just one of the things that's sort of common in the industry to sort of make sure that you maintain industry average types of expense ratio. So we continually evaluate where our caps are, so for the legacy Virtus funds, there's lots of them with caps and, as I indicated earlier, some of those caps we actually increased, beginning of the year, I think in particular, for a couple of our fixed income funds. So as it relates to the RidgeWorth funds, those funds had caps, and as part of a transaction, you usually always make a commitment to shareholders that there won't be any negative impact. So you sort of stand behind those caps. So that's really what we're sort of speaking to, and then Mike was just alluding to the fact that as you do a reorg and maybe some of the structural contracts change, since the fund already has a capped amount of expenses, it will get absorbed by that amount. So that's sort of what Mike was referring to.

Yes, you might see the lines that are impacted by mutual funds change, but as we reiterate, there will be no bottom line impact, right, to the extent, the investment management fee rate is impacted and sets at the range that I indicated on the call. You'd see offsets in the other rows like admin and transfer agency fees as adjusted.

Our next question comes from the line of Michael Cyprys with Morgan Stanley.

Just curious on the outlook for M&A, just how you're thinking about that today, where that's seeing your priorities stacked, just given the leverage here. And then what could make sense next just in terms of your outlook there, whether it's rolling up other platforms, prioritization of distribution versus additional products.

I think as I mentioned earlier in our remarks, the platform we have built really does lend itself to the ability to bring in other high-quality boutique managers who really like the type of model that we have and the distribution and other things that we can bring to the table. So that is something that we do believe is -- this is just a fundamental element of who we are. That being said, we're very excited about the organic growth opportunities that we have. As we've said since the beginning of the RidgeWorth transaction, by adding even more strong affiliated managers with great products and great capabilities and expanding our retail as well as institutional resources, we really see that as a great opportunity and a high priority. So that's really where our primary focus is. That being said, our model is to build for bringing on additional affiliates, and if it were -- if that were to be a good path for us to take, we would absolutely consider it. We've looked at things in the past. And we would do it only to the extent that it sort of made sense as an additive capability and that didn't conflict with anything that we previously had. But we see multiple opportunities, but right now, we're very excited about the organic growth side. But absolutely, we continue to consider inorganic opportunities.

And as you look out over the next several years, what should we be expecting in terms of M&A. It seems like the organic growth is maybe more of a priority in more near term. But just in terms of the pace of deals, maybe 1 or 2 a year or more episodic than that, and then you look out 3 to 5 years, how many affiliates do you think -- you kind of think your firm would have?

Yes, what I would try to make clear is, is I'm not trying to indicate that continuous M&A is a fundamental necessary requirement for our long-term growth strategy. It is one element of that, right. So I think, for us, it would not be a specific expectation of numbers of deals over a period of time. It would always be predicated upon the timing of the opportunity, how good that opportunity we think is for long-term growth and how financially attractive we can execute that transaction on because going -- hearkening back to an earlier question, we have to be very cognizant of being prudent custodians of shareholders' capital in terms of making sure that, at any point in time when we're doing a transaction that is something that we believe is the highest and best use of capital time. So we're really, for us, would probably be generally more episodic. I'm not sure if I'm crazy about that word, but it is certainly not something where we would be indicating to you that you should expect it to be a continuous ongoing thing that would always happen. But we are right now seeing great opportunities on the organic side, and we're very excited about executing on those.

Great. That's helpful. If I could just sneak a last one in here just on the technology front, we're seeing other firms across the industry use technology and digital to improve distribution. Just curious how you're thinking about that as an opportunity.

Yes, absolutely, I mean, the world has changed a lot in the client basis, and the intermediaries that we do business with are changing. So we continue to look for ways to be more effective in communicating, more effective in partnering with the firms that we do business with. So there are things that we're doing in that area, nothing that I would necessarily highlight, but that is increasingly becoming more and more a part of the total value proposition that we need to have with clients.

Our next question comes from the line of Surinder Thind with Jeffries.

I'd just like to follow up on an earlier question about just kind of the industry going through an investment cycle. And so when we kind of look at how that pattern has played out, it's been mostly the vertically integrated firms where there's more centralized decision making. And so part of the investment spend has gone towards things like distribution, but part of the investment spend is also going towards improving investment processes and maybe trying to incorporate Big Data and technology into the investment process. But with the multi-manager model, how are you guys thinking about that? I mean, it would seem that because the decision-making is done at each manager level, that it's a little bit harder to coordinate?

Interesting question. I mean, what I would say is there's a lot of reasons we believe in the multi-boutique model, right, and particularly in active management, and my personal view is, as the world is trying to determine what is the optimal mix of passive investing versus active investing, the active managers really need to demonstrate that they can add value and differentiate themselves. And I believe, fundamentally, that specialized teams, that culturally and philosophically have strong views and approaches to investing, over time, will have more sustainable, predictable results. So that's really the premise upon which we're advocates of the multi-boutique model. So I actually would not want to either influence or to homogenize any of the investment capabilities. I think our obligation is to make sure that our affiliated managers have tools and have devices and have data that they can have to execute what they do well. But really, the beauty of this model is each of them has a very distinctive and differentiated approach. And that's why each of them will do well or not well depending on the market cycle and how they do. In our model to have something that would really sort of send any kind of consistency would probably undo part of the value of the model because everyone would start looking alike. So what we really do and I personally very strongly believe that working with boutique managers that specialize in what they do, that live and breathe it and that view it as their contribution to the industry, I really think that's the way to go in the active management side.

Understood. So effectively, I guess, the level of investment or that -- of what to invest should be done at the manager level then, I think, that's what you guys are advocating for regardless of how the team does their approach.

Well, I would say it was a tweak because, again, what I said was, I think, in terms of investing, if we were to make data sources available or technology available, that would be where the benefit of our model is we can share those costs. So what I was saying is, in terms of development of specific processes related to how you manage money, for us, that will be more at the affiliate level.

Understood. And then one quick follow-up question. I noticed over -- during this transition period, the branding seems to have changed. Is that simply a function of the number of products you have out there? So before it used to be Virtus small-cap fund or Virtus this fund, now all of the funds basically have -- they're preceded by the actual managers themselves. So it would be like Virtus, Ceredex large cap and so forth. Was there a specific thought behind that? Or -- it's a change from your -- the -- historically, the way that you guys have thought about branding and pushing out product.

Yes -- no, and you're actually correct there. And it is something we've actually thought about over the years. I mean, our view is that Virtus really stands for

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1-point access to a collection of individualized specialist boutiques. So previously, we just used the Virtus brand in the open-end funds -- actually, on the closed-end funds and in other products, we actually have used the affiliate brands. And we have been thinking about changing to the co-branding approach for a long time, and really, the RidgeWorth transaction just made it very clear to us that we really wanted to take our opportunity to really do everything we could to sort of accentuate and focus in on the great collection of managers that we think we have that comprise Virtus Investment Partners. So we did change the branding of our open-end funds to really have the Virtus and then the individual affiliate that manages it. And we just think that provides a little more clarity and transparency, even to end clients on the mutual fund side. So now they can very clearly distinguish which of our fixed income funds are managed by which managers and the same on the equity side.

And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Aylward for closing remarks.

I just want to thank everyone for joining us today. And we certainly encourage you to give us a call and if you have any other further questions. Thank you.

That concludes today's conference. Thank you for participating. You may now disconnect.